More people are self-employed in the U.S. now than at any other time since 1957. What’s more astonishing is that number was reported at the end of 2019, well before COVID-19 upended the workforce and forced millions of people to look at their employment options.
If you’re one of the 68 million freelancers and self-employed workers, you know it comes with a lot of benefits and a few challenges.
Among those challenges, how to prove income when self-employed. We’ll take a closer look at that and what you need to know.
What Is Self-Employment?
The answer to that isn’t as simple as you might think. Most of the time it boils down to how you describe yourself for tax purposes. If you’re not sure exactly what you are, take a look at guidelines from the IRS to determine if you’re self-employed.
Here are three criteria:
- You operate a business as a sole proprietor or an independent contractor.
- You are a member of a partnership that conducts business.
- You are working for yourself as a freelancer either full or part-time.
It’s important to know what classification you and your business fall into because it will affect how and when you file your taxes. It will also guide your efforts to provide proof of income.
How to Prove Income When Self-Employed
There are a number of times when you might be asked for proof of income. The most common happens when you apply for a mortgage, a rental property, or a car loan.
Basically, any time you’re asking someone to loan you money or trust you to pay for a product or service over time, you’ll have to prove that you can make the payments.
When you work for an employer, the process is pretty straightforward. You can provide recent paystubs and bank statements. When you’re self-employed, you’ll need to provide several types of documents to verify your income.
Some people cringe at the thought of turning over their bank statements because it can seem invasive. (How much did I spend at Starbucks last month??) But your lender will want to see a record of regular deposits, as well as a snapshot of your expenses.
Most people have access to their statements through online banking. You’ll just need to print out however many the lender has requested. You may be asked for the last three to six months, but it’s not unusual for a mortgage lender to want the statements for the last year.
Your lender will review your statements to verify your income and make sure that you’re managing expenses. If you have a negative balance in your account every month, your application will likely be denied.
If you don’t have access to your statements online, you can visit a banking center and ask an associate to print them for you. You’ll need to show ID, and there may be a charge depending on how many statements you request.
Profit and loss statements (P&L)
Your profit and loss statement is just what it sounds like. It’s a financial document that you create to list your profits and your losses (expenses). Most companies, even small businesses, create a P&L every month.
If you have a P&L, you can provide it to your lender to verify your income. It’s a good business practice to create one because you want to track every dollar that comes in and goes out.
You can create a P&L through a program like Excel, or you can search for templates online that you can download. You may pay a small fee for the download.
Invoices and business contracts
You can also show your invoices as proof of income. Invoices and contracts are documents that detail the scope of the work you provided to a client and how much the client paid you.
You should have invoices for every job you do and every service you provide. Some lenders will want to match your invoices with your bank statements to verify you actually received payment for the work.
Filing taxes as a self-employed worker is a little more complicated than simply entering the information from the W2 you received from an employer. As an independent contractor or self-employed worker, you’ll receive a 1099-MISC from every client who pays you more than $600 a year.
When you work for an employer, the W2 you receive also shows exactly what the employer paid on your behalf for Social Security and Medicare. You pay half of the tax obligation, and your employer pays half.
However, as a self-employed worker, you are responsible for those obligations yourself. You’ll file your taxes using a Schedule C form. In this form, you will report your profits and losses. You’ll also calculate how much you will owe in Social Security and Medicare taxes.
It’s a little overwhelming the first time you deal with this. The IRS does have a special section on its website designed to help people just like you. It’s called the Self-Employed Individuals Tax Center.
You can use your tax return as proof of income because you will have reported the information directly to the IRS.
You can actually pay yourself from your company’s revenue and use those pay stubs as proof of income. Instead of receiving a pay stub from your employer, you’ll receive it from your own company.
You can use a free paystub generator online to create those pay stubs. You just plug in the information like your name, social security number and frequency of payment.
Separate Business and Personal Accounts
You can really make things easier on yourself by maintaining separate business accounts. While it may be easier to deposit all the money you make into your personal checking account, doing your taxes and verifying your income can get very complicated.
If you have a separate business account, it’s much easier to see exactly what payments are being deposited. You can also use this account to pay your bills. Since a portion of your business expenses is tax-deductible, it’s best to keep them separate.
Keep Good Records
One of the biggest reasons people choose to be self-employed is the freedom they have in becoming their own boss. But with freedom comes much responsibility.
It’s on you now to keep track of all your expenses and your profits, now that you know how to prove income when self-employed.
We hope this was helpful and invite you to check out more of our small business-focused articles.